Aviation Outlook Summit

Market liberalisation and evolving business models were in the spotlight at this year’s Australia Pacific Aviation Outlook Summit, held in Sydney at the end of July

1st Sep 2010

Politicians facing upcoming elections generally like to flatter their audience. Yet there was some credibility to the claim by Anthony Albanese, the current Australian transport minister, that the Australia Pacific Aviation Outlook Summit had become one of the highlights of his diary.

The Labor government that took power in 2007 has delivered on its promise to hold a root-and-branch review of the country’s aviation sector, the minister said, with the resulting ‘Flight Path to the Future’ white paper policy document benefitting from some 600 industry submissions.

The 130 policy shifts proposed in the white paper – some minor, some far-reaching – will be monitored closely across the Asia-Pacific region, not least since Australia has been among the most liberal and reformist aviation regimes for the past decade. Before that, recalled Andrew Parker, senior Vice-President of Public Affairs for Dubai-based Emirates Airline, the country had a perception of being a “hard nut to crack” as flag-carrier Qantas Airways feared any foreign airline in the market was “just trying to steal some of the London-Heathrow business”.

Emirates only prospered by convincing Australian authorities that their countrymen might like to travel to points in Europe other than London, and that there was pent-up demand in other markets for travel to Australia.

Embracing liberalisation

This message of liberalisation has now been embraced by the Australian authorities and is slowly being adopted by more countries around the region.
Singapore-based low-cost carrier Tiger Airways competes aggressively on Australian domestic routes, while domestically run Regional Express Airlines and British investor-led Skywest Airlines compete with Qantas Link in the regional markets on the east and west coasts, respectively. According to Peter Harbison, executive chairman of the Sydney-based think tank Centre for Asia Pacific Aviation, this proves that allowing foreign ownership of Australia-based airlines is good for competition.

The Gulf Cooperation Council, the Arabian Peninsula’s prototype free trade zone, aims to become the next region to implement full seventh-freedom rights within its confines.

Fathi Atti, head of government affairs at Abu Dhabi-based Etihad, said that, while there is still speculation over which countries will join the proposed Gulf single aviation market, it will come into existence by 2015. The United Arab Emirates, home to both Etihad and Emirates, is well-advanced in aviation liberalisation, as are nearby Qatar, Bahrain and Kuwait. Other states’ participation is less certain, however, Atti said.

Asia is not a unified market like the USA, nor is it a single market like the European Union. City pairs are further apart and the populations less wealthy than in those developed markets. These well-established points were highlighted at the summit by a succession of senior-executive speakers from Asia’s low-cost carriers (LCCs). Theirs is a different market, with different rules and different ways of making money, they stressed.

Azran Osman-Rani, the charismatic head of low-cost long-haul operator AirAsia X, used the conference to promote the airline’s lie-flat business class seats. The carrier has retrofitted 12 of the second-hand beds into its fleet with industry trend-bucking swiftness.

Two delegates at the summit had flown on the business class service from London to Australia via Air Asia X’s Kuala Lumpur hub, paying a little over US$1000. Osman-Rani pointed to such flyers as typical of his target market: professionals who would consider premium economy on a full-service carrier and who value a restful journey.

Breaking rules

“The business-class seats symbolise us breaking every rule in the LCC business,” said Osman-Rani. For him, the LCC norms of operating single-class services, point-to-point routes and a single aircraft type are more flexible than budget-airline pioneers such as Michael O’Leary would countenance.

Crawford Rix, incoming managing director of Tiger Airways Australia sees himself as being cut from the same cloth as O’Leary. He launched a tirade against frequent flyer points, the kind of market distribution not normally allowed under competition rules, he said.

“The industry loves to give labels to every airline, so are we a ‘low-cost, long-haul,’ or a ‘hybrid,’ or a ‘value full service’ or whatever?” he asked. Such tags were bunkum, Rix ventured, adding that success depends not on a strict adherence to a prescribed model, but by efficient execution of the business.

Restrictive bilateral air-services agreements between Malaysia and some other south-east Asian nations mean AirAsia X tendered for some route rights by offering a fully-inclusive product. “We became a full-service carrier, with baggage allowance and meals,” he said.

Osman-Rani’s counterpart at Thai LCC Nok Air, Patee Sarasin pointed to the carrier’s introduction of ticket distribution and payment via branches of the convenience store 7-Eleven as another example of innovation beyond the US-European LCC model, which stipulates only internet distribution.

In truth, many LCCs around the world have already broken free of the orthodoxy, mostly by signing deals with global distribution systems (GDS). Liz Savage, incoming chief commercial officer at Australia’s self-styled “new-world carrier” Virgin Blue, recalled her days at UK budget carrier easyJet, which has made inroads in the corporate market thanks in part to its GDS ties.

There is a growing realisation in Europe that, while the on-line sales channel allows airlines to trim spending on ancillary services, the trade channel still offers higher yields, Savage said.

“Successful airlines adapt to change no matter where they started,” she added.

Headlines

Export credit agencies (ECAs), like household insurers, used to have the reputation of being conspicuously absent during a crisis, only to reappear again at buoyant times. Yet aircraft leasing companies are finding it fiendishly difficult to shake off the insurers-of-last-resort after they were pressed into action by governments during the 2009 credit crunch.

The problem, as outlined during this year’s Australia Pacific Aviation Outlook Summit by Peter Harbison, executive chairman of the Sydney-based consultancy Centre for Asia Pacific Aviation, is that the ECAs “plugged the gap” left after suddenly risk-averse credit-rating agencies downgraded the creditworthiness of aircraft lessors, inflating the cost of aircraft acquisition for airlines. Governments then stepped in to safeguard the fleet expansion plans of their national and regional carriers, offering bond-backed guarantees.

According to Tony Ramage, executive vice-president for the Asia-Pacific and Middle East at Singapore-based lessor BOC Aviation, now that the market has more or less stabilised, it is time for the ECAs to leave the market, lest permanent distortion occurs.

“As part of our business model, we’re a speculative aircraft buyer; we buy in the bad times, lease in the good times,” Ramage explains. Yet the extension of favourable credit lines from ECAs has created a different market dynamic, one where airlines can purchase their own aircraft and actually compete with the lessors by leasing back any surplus from their fleets.

Spoilt for choice

David Phillips, capital markets fund executive at the global aircraft fund of share-portfolio management firm Investec, goes further.
“Since the start of 2010 there has been a change in the finance available to airlines. They are spoilt for choice now, as the ECAs have gone beyond their mandate and now offer government-backed credit,” he explained.

Recently, Singapore Airlines (SIA) regional subsidiary SilkAir received 22 bids for its sale-and-leaseback fleet expansion proposal. “We’re concerned that the market is a bit hot at the moment and the returns some of the mainstream lessors will make from deals this year make them unattractive companies in which to invest [our fund’s] money,” Phillips said.

What worries analysts is the prospect of airlines having immovable assets and rising debt. If a second recession hits Europe, this often fatal combination could push many airlines to bankruptcy, Phillips warns.

“The capital expenditure of some airlines back in 2007 was greater than revenue,” he says. The easy credit of 2010 risks sparking a similar rush to purchase, which should worry airline chief executives, he adds.

The benefit of leasing, though, is not lost on Patee Sarasin, chief executive of Thai low-cost carrier Nok Air, whose various crises – from avian flu, through tsunamis and political street protests – have reinforced a desire for flexibility.

“We’ve had operating leases since we started [in 2007], which have given us the flexibility to respond to the ups and downs of our environment,” he said. While start-up airlines are not usually offered the chance to purchase aircraft, Patee said the Thai government has extended a loan guarantee offer to Nok Air in a bid to stimulate the aviation sector.

“Even as we expand and even after we have taken the airline to its initial public offering, we will still lease, because we are debt-free and want to stay that way,” he says. Nok may even lease some of its Next Generation Boeing 737s from arch rival Thai International Airways, which acquired them with ECA backing.

Lessors have the edge

Phillips points out that lessors should outperform sale-and-leaseback deals in terms of total cost over the useful life of the aircraft. Not least since asset-management is a key task for lessors, rather than just one department within a sprawling organisation.

Ramage estimates most leasing companies to have a cost of equity of around 12 percent, whereas even with ECA-backed credit, airlines struggle to achieve 14 percent. He adds that there is a parallel in the retail sector, where stores exited the property purchase and management space two decades ago, as shopping mall developers proved more adept.

But an aircraft appears as a depreciating asset on the profit and loss sheet – easy to explain and easier to amortise. Lease repayments, on the other hand, just appear as heavy costs.

There is another perk for airlines too. Aircraft leased to other carriers provide carriers with capital gains, which are a handy revenue stream in uncertain times and fiscally beneficial in many regimes.

Yet there has been a quiet shift in the type of carrier leasing aircraft. Conventional wisdom had it that large airlines, normally former flag carriers, bought, while those further down the food chain had to contend themselves with renting.

“It’s very hard for a start-up to buy aircraft, whereas a top tier airline is spoilt for choice,” Philips says. However, for some years SIA has been moving steadily into the lease market and has been followed recently by carriers such as Qantas.

Ramage says this partly reflects the desire to ape the flexibility of low-cost carriers and partly comes down to capital management.